Chapter 7
Consumer behaviour
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-1
Learning objectives
• Develop further the two explanations of the
law of demand first presented in Chapter 3
• Discuss the role of marginal utility in explaining
consumer behaviour
• Describe the relationship between marginal
utility and the demand curve so that we may
better analyse how consumers allocate their
money incomes among various goods and
services
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-2
Learning objectives (cont.)
• Examine the implications of the addition of
the time dimension to our explanation of
consumer behaviour
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-3
Two explanations of the law
of demand
1.
Based on income and substitution effects:
–
–
Income effect:
the impact of a change in price on consumers real
income and quantity demanded
Substitution effect:
the impact of a change in price on relative expenses
and quantity demanded
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-4
Two explanations of the law
of demand (cont.)
2.
Based on utility theory: utility is the satisfaction
a consumer obtains from consuming a good
or service
–
–
Total utility (TU) is a measure (in units called utils)
of the total satisfaction derived from the consumption
of a good
Marginal utility (MU) is the extra satisfaction derived
from the consumption of one additional unit of a good
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-5
Two explanations of the law
of demand (cont.)
– Law of diminishing marginal utility: marginal
utility will decline as the consumer acquires
additional units of a particular product
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-6
The law of diminishing marginal
utility
Units of
Product A
First
Second
Third
Fourth
Fifth
Sixth
Seventh
Total
Utility
(utils)
8
15
20
23
24
24
22
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
Marginal
Utility
(utils)
8
7
5
3
1
0
–
2
7-7
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-8
Theory of consumer behaviour
Consumer choice and budget constraint
• Assumptions
–
–
–
–
Rational behaviour — consumers maximise total utility
Preferences (tastes) — clear cut preferences or tastes
Budget constraint — total money income is limited
Prices — prices are given for the consumer
• Utility maximising rule
– Consumer should allocate money income so that
the last dollar spent on each product yields the same
amount of extra (marginal) utility
– There will be no incentive to alter expenditure pattern.
The consumer will be in equilibrium
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-9
The utility combination of products A & B
Product A: Price = $1 Product B: Price = $2 Product B:
Price = $1
Unit of
product
Marginal
Marginal utility per
dollar
utility
(utils) (MU/price)
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
10
8
7
6
5
4
3
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
Marginal
utility
(utils)
24
20
18
16
12
6
4
Marginal
Marginal
utility per utility per
dollar
dollar
(MU/price) (MU/price)
12
10
9
8
6
3
2
24
20
18
16
12
6
4
7-10
Algebraic restatement of the
utility-maximisation rule
MU of product A
MU of product B
=
Price of A
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
Price of B
7-11
Marginal utility and the demand
curve
• Deriving the demand curve
– Preferences or tastes
– Money income
– Prices of other goods
• Create a demand schedule from the purchase
decisions as the price of the product is varied
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-12
Indifference curve analysis
Appendix to Chapter 7
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-13
Learning objectives
• Introduce the concept of the budget line and
explain its relationship to the prices of products
and consumers' money income
• Develop the concept of indifference curves
• Derive a demand curve using indifference curves
and budget lines
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-14
Indifference curve analysis
• Explanation of consumer behaviour and consumer
equilibrium based on:
• Budget lines
– Describes the income and price constraints on consumer
behaviour
• Indifference curves
– Describes consumers taste pattern
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-15
The budget line
• Shows the various combinations of two products
that can be purchased with a given money income
• Assume two products, A and B. Price of A is
$1.50 per unit; price of B is $1.00 per unit. Total
money income = $12.00
• Various combinations of A and B obtainable
with an income of $12.00, are illustrated in the
following table
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-16
Combination of A and B obtainable
Units of A
price $1.50
Units of B
price $1.00
Total
expenditures
8
0
$12
6
3
12
4
6
12
2
9
12
0
12
12
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-17
The budget line
• The budget line shows the combinations of
A and B obtainable given the money income
and prices
• An increase in income makes the purchase
of more of either or both items possible
• Price changes cause a change in the quantity
demanded of the items
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-18
A consumer’s budget line
12
Quantity of A
10
Income/PA = 8
8
(Unattainable)
6
Income/PB = 12
4
2
(Attainable)
0
2
4
6
8
10
12
Quantity of B
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-19
Indifference curves
• An indifference curve shows all combinations
of products A and B that will yield the same
level of satisfaction or utility to the consumer
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-20
An indifference schedule
Combination
Units of A
j
k
l
m
12
6
4
3
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
Units of B
2
4
6
8
7-21
A consumer’s indifference curve
j
12
Quantity of A
10
8
k
6
l
4
m
I
2
0
2
4
6
8
10
12
Quantity of B
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-22
Characteristics of indifference
curves
• Down-sloping
• Convex to origin
• Slope of indifference curve is the marginal rate
of substitution (MRS)
• Indifference map is a set of indifference curves
• Curves further away from the origin indicate
a higher level of utility
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-23
Indifference map
12
Quantity of A
10
8
6
4
I4
I3
I2
I1
2
0
2
4
6
8
10
12
Quantity of B
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-24
Equilibrium
• Equilibrium occurs at point of maximum
total utility (TU)
• Tangency solution
– Maximum TU is where highest indifference curve
just touches the budget line
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-25
Consumer’s equilibrium
12
Quantity of A
10
8
Y
w
x
6
4
2
z
I4
I3
I2
I1
0
2
4
6
8
10
12
Quantity of B
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-26
Deriving the demand curve
• Assume the price of one good falls
– The budget line pivots towards the origin of the axis
whose price has fallen
– The equilibrium position changes
• The new equilibrium involves more of the good
whose P has fallen
– This is the law of demand
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-27
Deriving the demand curve (cont.)
Quantity of A
Price of B
12
10
$1.50
8
1.00
6
4
x’
x
D
0.50
2
I1
I3
0
2
4
6
8
10
Quantity of B
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
12
1 2 3 4 5 6 7 8 9 10 11 12
Quantity of B
7-28
Next chapter:
An overview of
market structures
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
7-29